Is Biweekly or Extra Principal Better?

Amy and her husband would like to pay their mortgage off early with biweekly payments. The mortgage company won't accept biweekly payments but will accept extra principal payments. Is there a way around this?

QUESTION: Amy in Dallas and her husband have a 15-year fixed rate mortgage. They’d like to pay it off early with biweekly payments. However, the mortgage company says they won’t accept biweekly payments but will accept extra principal payments. Is there a way around this?

ANSWER: Let’s walk through what the biweekly mortgage is. That will help give you the answer. What your mortgage company is saying is they will apply as much to principal as you want to once a month. They will take your regular payment plus anything extra you want to pay, once a month. They will apply that and you will get the interest savings.

That’s really no different than the biweekly except that they are not going to just let you pile up payments and then do it.

The reason your friend’s loan paid off seven years early was not because of a half payment every two weeks. It’s because there are 26 two-week periods in a year. So your friend paid 26 half payments in a year. So 26 halves equals 13 whole payments. They paid an extra payment a year. If you pay an extra payment once a year, you will have almost the same effect as the biweekly program.

If you pay your regular payment plus the equivalent of an extra payment a year, sometime during the year, you’ll be within $10 of doing a biweekly. You can also divide that number by 12 and do it once a month. You pay your regular payment plus one-twelfth. If your house payment is $1,071 a month, we could round that off and say $100 a month extra to principal only in addition to your regular payment and you will have less than a $5 difference on your mortgage between that and a biweekly.

If the bank told you that you’d only save about nine months by paying an extra payment a year, that’s not true. If your interest rate is 4.375%, that’s not going to knock seven years off. That amount of time is only knocked off on an 8% interest rate. With your rate it will probably knock off about four years by doing a biweekly.

The point is this: Principal reduction can be done once a month in any amount you want it to be in addition to your regular payment. And every time you do principal reduction, you are paying off the loan faster because it slides you forward in that pre-calculated amortization schedule. So the next month when you pay your payment, more of it goes to principal than would have had you not prepaid principal.

You can do that once a year, you can do it once a month, you can do it every third month, or you can do it whenever you get money. So if you are debt-free other than your house and you’re ready to prepay your mortgage, it doesn’t have to be calculated the way we’ve been messing with it. The answer to the question is pay as much as you can pay so it goes away as fast as it can go.

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